Is it worth paying for ‘Active ’ investment management?

December 14, 2016

Written by Sam Pizzata – Resolution Wealth Partners

Most people would have money invested in some way. In fact, superannuation is the most common investment held. A superannuation fund would normally offer a range of different investments and like different items on restaurant menu, they will all have a different investment cost.

I could argue that most people would be happy to pay the lowest possible investment cost to achieve the highest possible investment return. Unfortunately this is unlikely. Low cost investments are low cost because they are generally very simple to set up and administer. Take for example a super fund that offers 10 investment options of which two of these options are for ‘Australian Shares’. The low cost option has an investment fee of 0.50% of the investment balance and the higher cost option costs 1.0%.

If they both invest in Australian shares then why do they have a different cost? It generally comes down to the level of investment activity. Low cost investments will simply invest into a basket of shares that match the share index (e.g. the ASX 100). Doing this is relatively simple and it means that the cost associated with providing this same investment can be low.

Higher cost investments provide more ‘active’ management. They may for example disregard an index and simply focus on what they believe will provide better performance. They may overweight certain industries or certain companies that have very good growth prospects or underweight companies that are expensive based on various valuation methods.

The real question however is whether it is worth paying more for active management. The answer is both yes and no. In fact, research shows that most ‘actively’ managed investments fail to outperform the index over long periods. Therefore, they are not covering the cost of their active management.

But at the same time some active managers do outperform the index consistently over long periods and therefore these same investments do produce a better outcome albeit with higher fees. The problem is most investors would not be experienced enough to know which investments or investment managers to choose.

It is also important to add that when markets rise (e.g. shares and property) then simply having money invested into these markets will generally produce a positive return. But when markets are flat or are falling then the opposite is true.

Right now, we are in a low growth, low return economic environment. Interest on cash and bonds are at historic lows and other assets such as shares have been very volatile for many years. Therefore, whilst simply choosing a low cost investment will save you on fees, it may also cost you on return potential. Good investment managers know where to find returns. They know which industries are profitable and which companies will become the next blue chips. They do not simply track an index and hope for the best but they look for assets which are undervalued or others that have large growth potential.

We believe that a well-managed investment portfolio could benefit from a mix of both low cost and active management. Having part of a portfolio invested in low cost index funds will help reduce the overall fee structure but still provide adequate exposure and diversification. Adding some funds that have more active management will increase the overall fee structure but also add greater potential for higher returns.

It is also important to note that every person has a different investment objective. For example a retiree is more concerned about having higher levels of income as opposed to a wealth creator that would be more focused on capital growth. A low cost index fund may not be suited for either investor. There are hundreds of different investments that can all have a different specialisation which when added to a portfolio can help an investor better achieve their investment objective.

Disclaimer: This editorial provides general information only. Before making any financial or investment decisions we recommend your consult a financial planner to take into account your particular investment objectives, financial situation and individual needs. Charter Financial Planning and its Authorised Representatives do not accept any liability for any errors or omissions of information supplied in this editorial.